As Stocks Fade, Should I Go To*Cash?

Discussion in 'Trade Journals & Stock Tips' started by baudwalk, May 31, 2015.

  1. baudwalk

    baudwalk Senior Investor

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  2. crimsonghost747

    crimsonghost747 Senior Investor

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    The thing is, you never know. Maybe Greece manages to pull some cash out of their ass, the US employment numbers are good and FED says "definitely no rise in interests before 2016" and then we will be instantly cruising higher and higher.

    I have my long term portfolio that is pretty much pure buy & hold. Though I am more careful as to adding new capital with the P/E of most stocks being way too high to my taste.
     
  3. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Trying to time the market is a very risky endeavor. I prefer to be far more "bottom-up" - I buy companies that appear to be undervalued and / or growing rapidly, and tend to also use a few bucks to make careful bets against companies that appear to be declining or broken fundamentally or perhaps ridiculously overvalued. I also tend to use put options as insurance against long positions in more volatile companies and industries such as many tech, biotech, and energy names.

    I will start to scale out of these long positions partially or completely when they appear to be no longer undervalued or growing. The opposite will be true for any short positions. And I'm always more careful with shorting, since the theoretical risk is greater while the possible reward is lesser than long positions.
     
  4. crimsonghost747

    crimsonghost747 Senior Investor

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    I've heard of a quite a few people doing this but never really understood how it works. Basically when the value of the stock declines the value of the put option goes up, but of course it also works the other way around. So do you just weight the stock and the put option in a manner that reduces overall volatility for your investments?
     
  5. Onionman

    Onionman Senior Investor

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    You've got to really look at your risk profile and what you are trying to achieve over the longer term. There's always the risk that you move out of the market, stick it in cash and things don't pan out the way you expect. It's not so much about whether the market goes up or down. It's more whether you get the returns you are looking for, when you're looking for it. There's always the opportunity cost of missing out on an investment return that could help you move towards where you want to go. You've got to think in terms of diversification and asset allocation. None of us can guarantee our market returns, but we can manage our risks a bit better.
     
  6. JR Ewing

    JR Ewing Super Moderator Staff Member

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    Right. It's like an insurance policy.

    It tends to work better with more volatile stocks. I'd be far more inclined to use a put option to protect the possible downside risk when buying Amazon or Netflix than when buying GE or even Apple.

    If you buy one hundred shares of Amazon for ~ $43,000, you might decide to protect any possible downside by buying a put that will give you the right (but not the obligation) to be able to short 100 shares of the stock at this price if the stock drops down below a certain price within a certain timeframe.

    If the stock doesn't drop below that certain lower price within the agreed upon timeframe, the option is worthless. If it does drop, you make money on the downside. If I really like a company, I often use such an opportunity to cash in the put, close out the short position, and hold the added long shares from that bought at the lower price.

    Options basically work on the supply / demand that pretty much everything else does. Stocks deemed more volatile or more likely to drop (or rise) significantly within a certain time (such as an upcoming earnings announcement) or at any time for whatever reason are generally going to have options that are more expensive than stocks that are more stable and / or not as likely to move one way or either way at a certain time or at any given time.

    The options on Amazon are generally going to be more expensive relative to their stock price than those of a company like GE.

    If you don't have 6 or 7 figures to play with, you might not want to worry about options at this time.
     
    Last edited: Jun 1, 2015
  7. crimsonghost747

    crimsonghost747 Senior Investor

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    Thanks for the explanation.
    Currently not planning on using them at all but it's always great to learn new things. Seeing as my overall portfolio is very defensive I thought that using put options to protect against a larger market downturn might become relevant at some point, possibly by using put options related to the SP 500. The tax implications of selling (and buying them back later on) can be horrible if the stock has been held for a long time and is now worth multiple times what I originally paid for it.
     
  8. JR Ewing

    JR Ewing Super Moderator Staff Member

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    As a hedge, you can also put a few bucks into something like SH, which is an ETF by Proshares that is short the S&P index. As you can imagine, it hasn't done so well in the past half dozen years. ;)

    I'm usually somewhere between 15-25% cash. I avoid extremes like going to 100% cash (or gold or other commodities, or short positions or whatever), and I am never really 100% long either. Always some long stocks, a little commodities, at least a little in shorts / puts, and at least some cash.

    I'm about 25% cash right now. For now, I've largely gotten away from long positions on the high flying high-beta names that don't earn any real money like NFLX and AMZN.
     
  9. User911

    User911 Well-Known Member

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    I'm with you. When the market is down, for the most part I view that as an opportunity to "buy stocks on sale". Sooner or later, the price usually goes up. Long term this is a pretty good strategy. Buy at a discount, watch the price go up and then sell if you want/need to.
     
  10. pwarbi

    pwarbi Senior Investor

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    I think the trick to any investment is timing. Everybody will have a story probably how they managed to cash out before a certain stock dipped or collapsed altogether. For me if I have gained a profit of a certain percentage on a stock, I'll cash anyway, even if that stock continues to do well, at least I'll know that I've made my money out of it already.
     

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